– EUR: headline risk but limited contagion
EURUSD has been consolidating around 1.2930-60 with sentiment shifting towards expectations of a constructive solution to the Cyprus crisis. The immediate risks to markets appear to have been contained by the ECB’s pledge to provide liquidity to the banking system. Cypriot banks will remain closed until next Tuesday and capital controls are likely to be put in place once they do re-open. BNP Paribas economists highlight three possible outcomes to the crisis: 1) eurozone countries back down from Cyprus’ contribution to the bailout plan; 2) Cyprus finds an alternative source of funding, including support from Russia or 3) Cyprus leaves the EMU. While option 3 is not completely off the table, we still believe it is highly unlikely as it risks setting an extremely costly precedent. Option 1 is likely to face significant political resistance in the euro area countries, especially in Germany, while putting Cyprus on an unsustainable fiscal path with a debt-to-GDP ratio of 180%. Thus we believe the ultimate solution could involve a more flexible approach from all three parties (EU, Cyprus and Russia). While the timing remains uncertain, some of the recent headlines suggested a new bill could emerge real soon. In markets, signs of broader market contagion have remained quite contained, with European equities higher and Spanish/Italian bond yields lower on Wednesday. In the near-term, EURUSD still faces significant headline risks but the pair now appears relatively cheap both relative to the euro periphery-core bond yields spreads (see chart) and our broader STEER valuation model. We see dips to 1.2806 technical support as a potential buying opportunity.
Click here to read the full report: FX Daily
BNP Paribas